White House and Congressional Budget Plans Battle It Out Over Charitable Deduction

For the sixth time in a row, President Obama last week included in his annual budget proposal a plan to scale back a tax incentive for charitable giving.

While nonprofits have successfully persuaded Congress to reject the idea every time, this year charities expect a tougher fight.

“I’m convinced a sacred part of our public policy is now up for scrutiny,” says Eileen Heisman, president of the National Philanthropic Trust. “This is a wake-up call for the charitable sector.”

Ms. Heisman’s concern is shared by other nonprofit leaders because this year the charitable deduction isn’t just in the Democratic administration’s cross hairs. It’s also being scrutinized by top Republicans in the House.

The head of the House Ways and Means Committee, Rep. Dave Camp, floated a plan last month that would also limit the deduction.

But his approach goes much further in seeking to draw tax revenue from nonprofits, and sends a strong message to nonprofits about how lawmakers want them to spend money.

It would levy taxes on salaries of $1-million or more at nonprofits, put a tax on donor-advised funds that hold money in their accounts for more than five years before directing it to charities, and charge private colleges if their endowments are too large in relation to the number of students on their campuses.

Ray Madoff, a law professor at Boston College, says Mr. Camp’s plan seems to be based on the concern that “we’ve got a lot of money stuck in donor-advised funds with no payout requirements or sitting in executive salaries.” His proposal, Ms. Madoff says, recognizes “that not all charitable dollars are equally serving the public good.”

Fallout Unclear

Although nonprofits have worked fiercely to protect the charitable tax deduction, some studies have shown that the proposed changes would lead to only a small reduction in giving. One study last year estimated that Mr. Obama’s plan would threaten at most $9-billion out of the more than $316-billion that charities receive from donors, while another scholarly report suggested that the Camp plan would cause a similarly small change.

Nonprofits say they are targets of Washington’s search for revenue to reduce the federal budget deficit in part because they are taking on more responsibility for dealing with poverty and other issues that the government won’t pay for.

Sue Santa, senior vice president for policy at the Council on Foundations, says that because “there’s a greater reliance on the nonprofit sector,” it has “heightened the scrutiny.”

Many Capitol Hill watchers have stamped “dead on arrival” on both the Obama and Camp packages, assuming they won’t go anywhere in a gridlocked Congress.

But the ideas in both blueprints should not be ignored because they set a starting point for all future tax deliberations, says Diana Aviv, president of Independent Sector, a nonprofit advocacy group.

“Those who say they are D.O.A. are making a mistake,” she says. “Sooner or later they will find their way into legislation.”

Often, such ideas circulate in statehouses around the nation rather than in Washington, says David Thompson, vice president of public policy at the National Council of Nonprofits.

“We’re trying not to hyperventilate over the Camp proposal,” he says. But he worries that ideas that could weaken incentives to give to charities will get “cut and pasted” into bills at the state level.

Mixed Impact

President Obama’s latest pitch to limit the charitable deduction is similar to provisions in his previous budget proposals. For upper-income taxpayers he would limit the tax savings from all deductions, including the one for charitable giving, at 28 percent. Individuals with income greater than $200,000 and couples with income greater than $250,000 would be subject to the proposed cap.

According to a December study by the American Enterprise Institute, charitable giving would drop $9.4-billion during the first year of a 28-percent cap on all deductions.

The study projected that gifts to organizations that disproportionately receive money from wealthy donors, such as universities, think tanks, and symphony orchestras, would experience a 24-percent drop in gifts, while giving to churches and religious institutions would remain nearly unchanged.

Although his deduction cap would limit the tax-saving benefits that donors could get from their charitable giving, another White House proposal seem to work in the opposite direction.

Under his “Buffett Rule” proposal, named for Warren Buffett, President Obama would set a minimum income tax of 30 percent for individuals with incomes greater than $1-million.

Taxpayers would be allowed to deduct gifts to charity from their income to reduce it to below $1-million, thereby escaping the 30-percent tax. William Daroff, vice president of public policy at the Jewish Federations of North America, calls such a policy move “ironic” given the administration’s repeated focus on the deduction

The Buffett provision, Mr. Daroff says, is an indication that lobbying efforts by charities over the past several years can influence the White House.

“This nod in our direction is a sign the administration hears us,” he says. “But we’re in an era where government is looking to squeeze revenue out of every turnip they can find.”

Mr. Camp, a Michigan Republican, takes a different approach to the charitable tax incentive. Instead of limiting the savings from the deduction, he would make the break available only for gifts that exceed 2 percent of a taxpayer’s gross income.

According to projections of the Joint Committee on Taxation, the measure would produce $50-million in revenue for the federal treasury over 10 years.

Experts at the Tax Policy Center, a joint project of the Brookings Institution and the Urban Institute, conducted an analysis on what would happen under a policy with a 1-percent “floor” before the deduction kicks in. They estimated that such a provision would reduce charitable giving between 0.7 percent and 1.2 percent in a year.

Funds Under Scrutiny

Mr. Camp’s proposal also seeks a big change in the rules affecting donor-advised funds, one of the fastest-growing types of nonprofits. Fidelity Charitable, the biggest of the funds, collected $3.6-billion last year, far more than virtually any other nonprofit and equal to the assets of some of America’s largest foundations.

Such funds face no requirements for distributing the money, and critics say too much money sits in tax-exempt funds instead of going to charity.

Mr. Camp’s proposal appears to reflect that concern by calling for organizations that administer the funds to pay a 20-percent tax on any money that sits in a fund more than five years.

The proposal caught many officials of donor-advised funds off guard. Kim Laughton, president of Schwab Charitable, says she was “confused and shocked” by the plan.

The proposal would generate a “minuscule” amount of revenue while diverting funds to the U.S. Treasury and away from their intended purpose of benefiting nonprofits, says Ms. Laughton.

“The government, I believe, is not a 501(c)(3),” she says, referring to the section of the tax code that governs charities.

Ms. Madoff, the Boston College law professor, disagrees. She thinks donor-advised funds should face pay-out requirements.

Although proponents of donor-advised fund say that payout rates average 16 percent a year, Ms. Madoff says that number doesn’t reflect the fact that large pools of money may be sitting idle in many accounts. Because there is wide variation in how regularly the money is channeled to charities, some funds may be paying out very little. “The overall payout rate tells us nothing about what an individual account’s payout rate is,” she says.

As nonprofit leaders gear up for lobbying efforts urging lawmakers to drop provisions they consider harmful, Ms. Aviv of Independent Sector says she hopes her colleagues will work harder to explain how the finances of nonprofit work and to convey the social importance of such groups.

Lawmakers, she says, “want to save stray cats and they want to clean rivers. These lawmakers love what charities do.” But, she worries, “they don’t want to talk about what it costs to run a charity.”